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Illuminating the Mystery of Shadow Payroll

Before an employer sends an employee overseas
for a long term assignment, the employer must decide whether the employee will
be paid from the home or host payroll, or through some combination of the two, Michele
Honomichl, founder, executive chairman, and chief strategy officer of Celergo,
said May 18.

This structure will help determine whether the
payroll in the employee’s home location or the payroll in the host location
where the employee is assigned will be the shadow payroll, or the method used
to ensure that employees overseas on international assignments are compliance
with tax reporting and payment obligations in multiple jurisdictions, Honomichl said at the American Payroll Association's 2018 Congress in National
Harbor, Md.

Running payroll in the home country allows
employees to remain on home-country benefit plans, provides funds to meet home-country
obligations such as mortgages or debt, facilitates ongoing enrollment in the
home country’s social security system, and helps employees who are parents with
school-aged children maintain in-state tuition, Honomichl said.

Processing payroll in an employee’s host
country can provide employees with funds to meet host country living
obligations and can encourage participation in a host country social security
system since liabilities can be easily calculated.

However, host-country payroll may complicate
participation in home-country employee benefit plans such as retirement, hinder
ongoing participation in home-country social security systems, and requireworkers
to switch payrolls for each work assignment in a different country.

Split payroll, where payroll in the host
country and the home country each deliver a portion of employees’ pay into
designated bank accounts, may address some of these issues by enabling employees
to use the pay for host-country living obligations and obligations in their
home country. Split-country payroll also may reduce the risk of exchange rate
exposure.

Calculating taxes at employees’ home location
and running a shadow payroll simultaneously in their host country is the most
common method for operating a shadow payroll, Honomichl said.

Host tax programs include tax equalization
where the employer pays the host tax and gross-up is needed, employees are treated
like a local for local payroll and pays host taxes so no gross-up is needed, or
the employee is on a home payroll but pays host taxes through a deduction on
their home payroll so no gross-up is needed, Honomichl said.

Tax equalization is a common technique used by
U.S. employers to show how much tax would be paid at home if an employee was
not on assignment in a host country.

There is no one-size-fits-all approach to the
taxability of income earned by employees assigned to a host location, Honomichl
said.

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